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Equivalence of Input and Functional Separation: A Framework for Analysis

This paper identifies the importance of providing access on equivalent terms to all operators using Next Generation Networks. The report looks at the reality of competition in telecommunications, the UK experience of setting up a functionally separated acc

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This report has been prepared in the context of the proposal by the European Commission to introduce functional separation as an “exceptional remedy” and in the light of proposals in various other countries, for example New Zealand and Australia. There has been considerable debate about the merits or otherwise of functional separation, but much of it does not put functional separation in its proper context and fails to analyse the role it plays in an overall regulatory environment designed to address competition problems. This report seeks to answer three key questions: i) What is it about the structure of electronic communications markets that gives rise to enduring competition concerns? ii) Have equivalence and functional separation been well-designed and implemented in the UK to address enduring competition problems and what does this imply for other fixed communications markets? iii) Can we expect equivalence and functional separation to lead to improved intermediate (wholesale) and final consumer outcomes? Our examination of the evidence leads us to find that We find that:

i) The economics of the local loop mean that, at least in the medium term, there are likely to be enduring competition problems at the access level, which will need to be regulated to ensure competition downstream.

ii) The evidence from the UK suggests that equivalence and functional separation have addressed enduring competition problems in local access markets that serve residential consumers, although there remains doubt about their efficacy in business customer markets. This suggests that the use of these remedies would be effective in addressing discrimination problems elsewhere.

iii) Equivalence and functional separation are not cost-free remedies and may impose marginal costs on the regulated operator that it would otherwise not incur. However, the arguments put forward that these remedies will damage investment incentives appear to us to be erroneous. We conclude that the removal of discrimination leads to greater dynamic efficiency gains, which outweigh static efficiency losses to the extent that they occur.